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Modelling the US$/A$ Exchange Rate Using Cointegration Techniques

Author

Listed:
  • Karfakis, Costas
  • Phipps, Anthony

Abstract

Recent evidence indicates that Australia's real effective exchange rate, its terms of trade and a long-term real interest rate differential form a cointegrating relationship. This paper uses this evidence to analyse the nominal US$/A$ exchange rate. The US$/A$ rate is found to be cointegrated with the terms of trade and relative price levels. However, interest rate differentials appear to add nothing to this long-run relationship. Estimated error correction models suggest that there is a substantial two-way relationship between nominal exchange rate changes and changes in the terms of trade. This evidence indicates that the small, open-economy assumption of exogenously given terms of trade may be inappropriate when modelling movements in the US$/A$ exchange rate. Changes in a long-run interest rate differential, possibly reflecting differences in expected inflation rates, contribute significantly to an explanation of short-run changes in the nominal exchange rate.

Suggested Citation

  • Karfakis, Costas & Phipps, Anthony, 1996. "Modelling the US$/A$ Exchange Rate Using Cointegration Techniques," Working Papers 238, University of Sydney, School of Economics.
    • Handle: RePEc:syd:wpaper:2123/6738
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    Keywords

    Cointegration; Exchange Rates; Terms of Trade; Interest Parity; Purchasing Power Parity;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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